The Securities Litigation Expert Blog

PREPA Restructuring?

Posted by Jack Duval

Dec 24, 2015 10:33:59 AM

PREPA announced a restructuring last night that puts it squarely in the realm of Ponzi finance. The Puerto Rico utility will issue $115M of new debt in order to pay interest on existing debt. As Hyman Minsky taught us, this is the definition of Ponzi finance (the last phase of the financial fragility cycle).

The new debt is to be purchased by two of the largest PREPA bond insurers: Assured Guaranty and National Public Finance Guarantee ($50M) and the Ad Hoc Group of hedge funds which own the majority of Puerto Rico municipal Bonds ($65M).[1]

In theory, there will eventually be a restructuring that will give PREPA $700M in interest rate relief over the next five years and a permanent haircut of $600M.[2] This would be accomplished through a debt exchange where the old bonds were exchanged for the new (haircut) bonds that would have an investment grade credit rating. The new bonds would be credit enhanced by surety of the bond insurers.

There’s only one problem with all this. PREPA is still losing money and the debt exchange will require increasing power rates by adding a surcharge that flows directly to the bond trustee.[3]

Chart One: PREPA Financials[4]

 PREPA_Financials.jpg

The High Cost of Restructuring

Allow me an anecdote: in a recent case in which I was engaged, a Puerto Rico resident who lived in a modest house, well outside of San Juan, was paying $1,000 per month to PREPA for power. Such high rates are an incredible drag on the economy. Higher rates will further depress the economy. Also, the restructuring is contingent on the rate surcharge, which will have to be passed after numerous other tax increases in the past two years and, more importantly, in an election year.

 In Order to Save the GDB, We had to Destroy It

In the Byzantine system of Puerto Rico debt payment priorities it is not clear how this works out. The Government Development Bank (“GDB”) balance sheet has been taking body blows. Over 21 percent of GDB assets are in Highway and Transportation Authority (“HTA”) bonds which are currently trading around 42.[5] The Governor has already enacted clawback provisions in the HTA bonds to meet principal and interest payments that were due on December 1 for (I kid you not) GDB debt.[6] Thus, in order to meet the GDB’s debt obligations, the Governor had to destroy the GDB’s balance sheet.

Chart Two: Puerto Rico Highway and Transportation Authority Bond[7]

  HTA.jpg

The GDB has at least $740M exposure to PREPA.[8] Coupled with their $2B exposure to HTA, their bonds have been getting crushed.

Chart Three: Puerto Rico Government Development Bank Bond[9]

 GDB.jpg

Stay tuned, this is far from over.  If a Chapter 9 bankruptcy becomes available to the Commonwealth's agencies, all bets are off, including the proposed Superbond.

__________

Notes:

[1]                 Mary Williams Walsh, The New York Times, “Puerto Rico Utility Reaches Deal with Bond Insurers in Effort to Avoid Default”. Available at: http://www.nytimes.com/2015/12/24/business/puerto-rico-utility-reaches-deal-with-bond-insurers-in-effort-to-avoid-default.html?_r=0; Accessed December 24, 2015.

[2]                 Id.

[3]                 Bloomberg; “Puerto Rico Electric Wins Debt-Restructuring Deal with Creditors; December 24, 2015.

[4]                 Source: Bloomberg

[5]                 GDB Liquidity Update; October 17, 2014; 6.

[6]                 Michelle Kaske; Bloomberg; “Puerto Rico Avoids Default by Redirecting Revenue From Bonds; December 1, 2015.

[7]                 Source: Bloomberg

[8]                 See Supra note 5.

[9]                 Source: Bloomberg

For information about securities expert Jack Duval, click here.

For my previous coverage of the Puerto Rico municipal bond crisis, see this.

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Topics: municipal bond crisis, Puerto Rico, UBS, securities litigation, GDB, Restructuring, PREPA, HTA

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